Bankruptcy Court Within Fourth Circuit Permits Fraudulent Conveyance Claims to Move Forward Under IRS 10-Year Reach Back Period

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A recent opinion by the United States Bankruptcy Court for the Western District of North Carolina kept alive a bankruptcy trustee’s fraudulent conveyance claims based on, in part, the Internal Revenue Code (“IRC”) 10-year statute of limitations period to avoid fraudulent transfers—rather than a shorter limitations period under state law. The case is Mitchell v. Zagaroli et al. (In re Peter Lawrence Zagaroli), Case No. 18-50508, Adv. Proc. No. 20-05000, 2020 WL 6495156 (Bankr. W.D.N.C. November 3, 2020).

In Zagaroli, the Debtor filed for relief under chapter 7 of the Bankruptcy Code in 2018. In 2010 and 2011, the Debtor is alleged to have transferred certain real property to family members for insufficient consideration. The Internal Revenue Service (“IRS”) filed a claim in the Debtor’s case. The Trustee filed an adversary proceeding against the recipients of the alleged transfers under a constructive fraudulent conveyance theory, utilizing Section 544(b) and Section 548(a)(1)(B) of the Bankruptcy Code. The defendants moved to dismiss the Trustee’s claims asserting that the claims cannot reach back and recover the alleged transfers due to the four-year limitations period under North Carolina fraudulent conveyance law.

Looking to the statutory text of Section 544(b), the Court held that because the IRS was a creditor in the case, Bankruptcy Code Section 544(b)(1) permits the Trustee to step in the shoes of the IRS and use any laws that the IRS may use outside of the bankruptcy proceeding. Specifically, IRC Section 6502 provides the IRS with a 10-year statute of limitations to avoid fraudulent transfers. Accordingly, the court denied the defendants’ motion to dismiss and held that the Trustee sufficiently stated a claim under the IRC’s 10-year limitations period.

Courts have not taken a uniform approach regarding the ability of a Trustee to utilize the substantial look back period under the IRC in fraudulent conveyance litigation, when the IRS is a creditor in the bankruptcy case. The United States Court of Appeals for the Fifth Circuit is the only federal appellate court to have addressed the issue, holding that a Trustee may not utilize the IRC limitations period. The case is MC Asset Recovery LLC v. Commerzbank A.G. (In re Mirant Corp.), 675 F.3d 530 (5th Cir. 2012) and is considered to be the minority view.

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Opinions and conclusions in this post are solely those of the author unless otherwise indicated. The information contained in this blog is general in nature and is not offered and cannot be considered as legal advice for any particular situation. The author has provided the links referenced above for information purposes only and by doing so, does not adopt or incorporate the contents. Any federal tax advice provided in this communication is not intended or written by the author to be used, and cannot be used by the recipient, for the purpose of avoiding penalties which may be imposed on the recipient by the IRS. Please contact the author if you would like to receive written advice in a format which complies with IRS rules and may be relied upon to avoid penalties.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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